How the Mighty Have Fallen

It's not entirely clear what changed. Parker thinks that "one cause is the dramatic increase in pay for performance." In the past quarter century, salaries for top executives and managers have increasingly consisted of stock options, year-end bonuses, and sales incentives, he says. When the economy thrives, pay rises; when it sours, pay falls. Parker also cites the growth of professionals (lawyers, doctors, accountants, consultants) among the economic elite. "When the demand for elective surgery or legal services or consulting services goes down, so do their incomes," he says. Even among the top one tenth of 1 percent, wages represent half their income, and "proprietors' income" (essentially profits from a business or partnership) accounts for another quarter. The stereo-type of the rich living mainly off dividends and interest income is increasingly outdated. Many of the wealthy are owners of small businesses whose well- being is—to some extent—hostage to the business cycle.

It will strike many, no doubt, that the setbacks and anxieties for the country-club set are just deserts. Some will correctly note that well-paid CEOs and investment bankers helped bring about the economic crisis. They're just getting their comeuppance—and it's about time. Others will point out that countless studies have shown that, in recent decades, the gap between the rich and the rest has widened. From 1990 to 2006, for instance, the share of pretax income received by the top 1 percent grew from 12 percent to 19 percent, says the Congressional Budget Office. The present reverses are a healthy correction. So goes the argument.

All this is understandable, but incomplete. The criticism usually presumes that if the rich and near rich get less, someone else will get more. Redistribution achieves a better social balance. Sometimes that happens. But sometimes when the rich get less, no one else gets more. Regardless of how the rich earned their money—trading bonds, performing surgery, starting new companies, providing legal work—it's no longer so lucrative. The rich get poorer, but no one else gets richer. Society is worse off.

"Trickle-down economics" is a despised phrase and concept to many, but it also embodies a harsh reality. The rich often play a pivotal role in U.S. economic growth, and if they are enfeebled, then the consequences are widespread. Consider:

??Consumption spending, the economy's main engine, is skewed toward the upper classes, because they have most of the income. In 2009, households with more than $200,000 in income account for 3.4 percent of the total but will generate almost 14 percent of consumer spending, estimates economist Sterne. Households with incomes between $100,000 and $200,000 represent about 14 percent of the population and 34 percent of spending. Together, these groups generate nearly half of U.S. consumption, although they're only a sixth of the population.

??Similarly, the rich pay most of the taxes. In 2006, the richest 1 percent paid 28 percent of all federal taxes, estimates the CBO. The richest 10 percent (including the top 1 percent) paid 55 percent. The system is progressive—that is, the richer people get, the more of their income they pay in taxes. In 2006, the effective rate for the top 1 percent was 31 percent, reflecting all federal taxes. By contrast, the poorest fifth paid an effective rate of 4 percent. (State and local taxes are less progressive, because they rely more heavily on regressive sales taxes.)

???The wealthy dominate charitable giving. In 2004, families with a net worth exceeding $5 million made up about 1.5 percent of all U.S. families but accounted for 27 percent of contributions, according to the Center on Wealth and Philanthropy at Boston College. Those with a net worth between $1 million and $5 million, about 7 percent of all families, represented another 20 percent of contributions. So, a tenth of American families made nearly half of all gifts.

??Wealthy individuals are an important source of money for venture capital—funds invested in startup companies. Individuals and families represent about 10 percent of VC money (most of the rest comes from pension funds, college endowments, and insurance companies).

When the affluent retrench, they drag a lot with them. For example, the financial crisis led to a 44 percent fall in year-end bonuses at Wall Street firms, to $18.4 billion in 2008 from $32.9 billion in 2007, according to the New York state comptroller. No doubt that struck many as overdue and insufficient. Bankers were overpaid, and huge year-end bonuses encouraged excessive risk-taking. The trouble is that the loss of taxes on the bonuses blew a $1 billion hole in the state's budget and made it harder to pay for schools, health care, and prisons.